The market is suffering a death by a thousand cuts

L.A. Little, a professional money manager trading his own accounts while
managing investment funds for qualified investors, is the author of three books (Trade Like the Little Guy, Trend
Qualification and Trading, and Trend Trading Set-Ups) and has written extensively for many popular publications, such as Stocks and Commodities, Active Trader, TheStreet.com, RealMoneyPro.com and Minyanville.com. He writes daily on his website
Technical Analysis Today, which offers
tools and services that implement the concepts he espouses,
and can be reached at tat@tatoday.com.

Back in March, the probabilities of a range trade at the highs looked quite probable, and a column alerting readers that a roller-coaster market was taking shape was shared here. That up and down movement lasted for almost half a year, until one week before the markets came crashing down, the probabilities of a larger fall were high enough to issue a direct warning.

Now, five weeks into the downdraft and with the indexes poised to try and break lower still, there is enough evidence to suggest that even though lower prices are most likely still to come, it is unlikely they are going to come in a crash manner as many keep expecting. Instead, my neoclassical work suggested that it will come by way of a death-by-a-thousand-cuts-type decline.

As always, we turn to the charts to see how this decline is unfolding and reintroduce another of the unique neoclassical tools — the trend mean-time-to-failure (MTTF) indicator to underscore the probabilities of a longer, protracted battle of ups and downs with a slow downward bias unfolding.

Starting with the indexes, where the Monday madness from Aug. 24 saddled them with significant downside spikes, yesterday's (Tuesday) two-bar reversal (under the prior day’s low and back over after another fast extended directional move) argues for a sideways-to-higher day today.

Note that at these lows, sellers began to simply walk away and were unwilling to sell at the previous lows. That is supply and demand at work. Supply is unwilling to be offered at lower and lower prices. To create a transaction, higher prices are needed.

The same story is true of the Nasdaq. At this lower price boundary, supply becomes restricted, and the offers dry up.

And if you walk overseas to Europe, there the picture is the most clear, as Germany actually tested the August lows, and there was a total refusal on the part of sellers to sell at those levels.

Folks, if sellers are unwilling to sell at lower prices, then prices will rise.

That's the good. Here is the bad. On the indexes, high-volume lows still exist and without a test from August of this year and from October a year past. That's true on the S&P 500, and the Nasdaq and is most visible on the weekly Nasdaq chart.

Neoclassically, we know that the odds are high that those tests will eventually take place. We also have one other tool that tells us that we are in the beginning stages of bearish trends — on both the short- and intermediate-term time frames (daily and weekly time frames). That tool is the cumulative mean-time-to-failure trend-probability table (Trend MTTF). Using the Nasdaq, on the short- and intermediate-term time frames we can see just how young this bearish trend is.

The way to read this indicator is as follows. It is a measure of the cumulative probability that the trend will end. The longer the trend persists, based on all trends to date, the probability of its demise increases, and it increases at a rate dependent on the type of trend (how it is qualified) and on what time frame it exists. In the chart above, both the daily and weekly bearish trends are very young, and their probability of transitioning away from bearishness is minimal.

Historical evidence suggests that when a trend moves to about a 70% probability, then it is becoming stretched. If we scroll down on the MTTF probability tables, we can see that in roughly six weeks, the short-term trend will be stretched to the downside, and in approximately half a year, the same will be true for the weekly chart.

Now, this doesn't imply trend can't change earlier. What it says is that the probability that a bearish trend persists for a good while is pretty high — at least for now, and you shouldn't be betting on it ended without good reason.

So, even though we are set to bounce near term, the bearish trends that have taken root look to be here to stay for an extended period. Thinking about the calendar, this could set up a late October rally early November rally that raises hopes only to be squashed later on.

Fundamentally the U.S. is not nearly as bad off as needed to create a crash and the charts don't support that notion either. Add to it the fact that central banks and governments will act if market dynamics dictate action.

So, what all of this suggests is that even if we are going lower eventually, it's going to be a death by a thousand cuts type move most likely - not a crash and burn scenario.

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